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On the Incidence of a Financial Transactions Tax in a Model of Fire Sales

Felix Bierbrauer
University of Cologne, Working Paper Series in Economics No. 55, 2012

JEL codes: H22, G18, G21, G28

Keywords: financial transactions tax; financial stability; financial markets; cash-in-the-market-pricing; marking-to-market

This paper studies the impact of a financial transactions tax on a financial market where financial institutions trade with each other. Assets are marked to the market and financial institutions with negative equity are forced out of business. There are two main results: First, if all banks have enough liquidity so that they can honor their short-term obligations, a financial transactions tax is entirely neutral. Second, in a model with correlated investment risk and short-term financing of banks, a financial transactions tax contributes to financial distress and undoes other policy measures that are used to stabilize financial markets.

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